Progressive Democrats want the Fed to take a more expansionary role in the economy by stepping up efforts to boost employment, stave off climate risks and tackle inequality. Conservatives want it to stick to its monetary stance, pay more attention to containing inflation, and reduce its footprint in financial markets and on the regulatory front.
Whoever the Democratic president elects, the next Fed chief has to grapple with important issues of monetary policy and the nature of money.
Here are some of the biggest challenges over the next four years:
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After the outbreak of the coronavirus pandemic, the Fed cut its benchmark interest rate to near zero overnight and bought trillions of dollars in government bonds and mortgage-backed securities.
With the economy recovering quickly, Fed policymakers are likely to begin winding up bond purchases later this year.
However, under a new monetary policy framework that was passed last August, they plan to wait until the economy has reached full employment and inflation is at and moderately above 2% before raising interest rates.
It’s a promise that a new Fed chief may find difficult to keep. Most Fed politicians believe the current surge in inflation, above 2%, is temporary. But if the price hikes prove to be more sustained, the central bank chief might end up overseeing a rate hike before all budding workers can get a job.
In August, 5.3 million Americans were less employed than before the pandemic.
“There are a lot of things that are going to change in the future that are really structural aspects of the economy that I think we need to pay a lot of attention to to make sure we are appropriate.” Adapting our policies to the economy, “Cleveland Fed President Loretta Mester said in an interview in August.
FED AS A GUARD DOG
If the Fed’s new framework results in monetary policy remaining relaxed longer in pursuit of a stronger labor market, analysts say financial regulations may need to be tightened to avoid risky behavior that could trigger a crisis.
“Financial regulation is second on the agenda, in my opinion, and most of all it remains to contain financial risk in an environment of historically low interest rates,” said David Wilcox, a former top Fed economist and currently a senior fellow at Peterson Institute for International Economics.
Whoever heads the Fed must also look at financial stability in general, Wilcox said.
Systemic weaknesses in trading US Treasuries and money markets were exposed last March when the financial markets nearly collapsed in the wake of the pandemic-induced closings.
The growing popularity of “stablecoins,” a largely unregulated form of cryptocurrency that can be pegged to the dollar, also poses a growing threat to financial stability, argued Boston Fed President Eric Rosengren.
A central question will be whether the Fed decides to issue its own digital currency. Powell has so far been non-binding. Fed Governor Lael Brainard, the other top candidate for the Fed’s top post, said it was hard for her to imagine not doing so. The Fed plans to publish a discussion paper on the matter in September.
Proponents say that a well-designed digital currency could lower transaction costs and improve access to the banking system for disadvantaged groups. Others fear that banks could be sidelined if American households and companies forego regular checking accounts and go straight to the Fed.
China and other countries are already issuing their own digital currencies, as are private companies such as Amazon.com Inc. If widely adopted, such tokens could fragment the payment system, threaten the Fed’s ability to control interest rates, and the global development of the US dollar endanger dominance.
“The Federal Reserve needs to figure this out pretty quickly,” said Andrew Levin, an economics professor at Dartmouth College. “This is a challenge that can have the dust settle in the next year or two.”
The Fed chief will also be under pressure to understand and address the effects of uncontrolled forest fires, overpowering hurricanes and other devastating effects of climate change on economic and financial markets.
Both Powell and Brainard say it is the Fed’s job to ensure that banks are resilient to, for example, falling assets due to wild weather events or government mandates to limit carbon emissions.
However, the Fed’s mandate does not include directly addressing climate change, as is the case with some other central banks.
The Fed set up two internal bodies last year, one on climate-related risks for individual banks and the other on system-wide threats. It also became the last major central bank to join the Network for Greening the Financial System, which develops recommendations for central banks to respond to climate change.
Either of these could help the Fed chief do more on the climate front, although a more aggressive stance on par with other central banks without new laws could prove difficult.
Racial and gender differences
Fed officials have also become more open to the potential that race and gender inequalities can adversely affect economic growth https://fedcommunities.org/data/closethegaps.
US Senator Pat Toomey, a Republican, calls this “Mission Creep”. However, many on the left of the political divide say this does not go far enough, blaming the Fed’s asset purchase program of filling the pockets of the rich by raising stock prices.
“This is causing a lot of turmoil in what the Fed is doing to address some of the big problems of our time, including inequality and inequalities in labor market outcomes and wealth distribution,” said Julia Coronado, a former Fed economist who is now president of MacroPolicy Perspectives.
Whoever leads the Fed could refine their tools to potentially fill some of these gaps, including through programs to encourage small business lending and regulatory changes that encourage banks to work with consumers struggling to repay their loans said Coronado.
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